The ‘Baking’ of GST

INhis Speech at FAPCCI, Hyderabad on January 17 this year, the CESTAT President, Mr Justice Raghuram, said, “When I saw the GST Bill, it is mind-boggling constitutional complexity. It is neither the exclusive list nor the concurrent list; it’s a fourth dimensional animal. It is post Einstenian Physics. Heisenberg’s uncertainty of quantum mechanics is elementary compared to the complexity of this. Even the political complexity of States and Union coming together on a continual basis to ratchet the policy of GST is a huge challenge. It is an economical challenge, it is a political challenge, policy challenge, an administrative challenge …”

Going by the latest developments where the GST has been accorded the official status of a‘poster child’ by the present political establishment, Justice Raghuram’s speech appears to be so precise a prognosis. Let me pick up the first component of constitutional complexity where certain items from the State List, the Union List and the Concurrent List such asalcohol, petroleum products, real estate and electricity are going to be kept outside the ambit of the present reform agenda. Although one may not see much rationale for such a political decision but the global studies tangibly establish that there is no standard design for a good VAT or GST rather the design is a direct outcome of the expression of political consensus and democratic discourse. Unlike what Leo Tolstoy once wrote that all happy families are alike but as per most GST experts worldwide, it does not work for GST. All good GSTs are not similar but are equally efficient. They may share certain virtues but they differ in design, sizes and styles.
One good example of such a political conundrum India is witness to, is the 1% additional duty on inter-state trade of goods as proposed by the GST Bill to compensate the revenue loss of exporting States. It is learnt that the Rajya Sabha‘s Select Committee which has submitted its final report to the House and which may be debated in a couple of days, has not called for outright deletion of the same albeit Congress legislatures have submitted a dissent note and vociferously called for guillotining it from the Bill. The only change the Select Committee has suggested is that such a duty should not be levied on stock transfer– one of the critical worries of the India Inc. In addition, the Committee has also recommended full five-year compensation to the States rather than a tapering graph. The Committee is believed to have also recommended that the expressions like ‘supply’ and ‘band rate’ should be defined in the Bill itself.

Let’s now move to the second component of Justice Raghuram’s Speech – the political complexity of States and Union coming together. The fact that the process of ‘baking’ of GST has taken almost a decade clearly indicates the inherent presence of political complexity in the relationships between the stake-holders. The fact that no decision has been taken so far with respect to the Revenue Neutral Rate (RNR), the list of zero-rated and exempted items; the exemption threshold, the number of tax rates etc, evidently points towards the great political challenge awaiting all the stake-holders.

A studied look at the 50-year-long history of VAT across the world may reveal that the introduction of GST had less to do with its design and other technical characteristics and more to do with the nature of polity prevailing in a country at the time of its introduction. Secondly, the timing of introduction of such a reform is very critical for success and also for the political longevity of the party in power. Let me cite one pertinent example to illustrate these two points. The Canadian VAT/GST has come to be seen as the closest to the complex dual GST India is gearing up for. But when Canada introduced it in January, 1991, it was recession time and a new tax system evidently boomeranged in the face of the ruling party which lost the elections in 1993. As against this experience, there is a happy experience recorded by New Zealand which introduced GST in 1986. It was levied on all products, including clothes and food stuffs. And it was accompanied by redistribution schemes for the poor hit by the new tax system. And much to the surprise of VAT experts across the globe, it was not the ruling party but the party that proposed exemptions for the poor that lost the ensuing polls.

Whether there is any message for the Modi Government in such a recorded history is seemingly debatable but what is certain is that no ruling party should rush into such a tricky but inevitable tax reform. Any attempt to catch the April 1, 2016 deadline would be akin to a rush. This is more so when a political consensus has eluded the negotiators on all the key components of a hybrid design. Then comes public discussion which should be given a minimum of six months. It must be remembered by the GST makers that apart from a good political leadership being an inevitable value-added ingredient for any reform, participation of taxpayers in the making of critical provisions of the new legislation should not be truncated by reducing the time period (after Discussion Paper in 2009 no other documents have been made public for consultation). It is a fact that there is no time-tested formula to finalise the DESIGN of a model VAT system as it has to be commensurate with the prevailing politico-socio & economic indicators but all efforts must be made to reduce the number of distortions. A good GST DESIGN would make good tax administration easier and a bad one would make it DIFFICULT to enforce. A new system born with multiple distortions sponsored by political parties wielding influences like the 1% additional duty would have a direct relationship with the kind of GST frauds India may have to witness once the system becomes operational.

No doubt, GST is several times a better tax system for garnering dependable revenue (thanks to its inelastic nature)than income tax which is technically more complex, administratively more demanding, more prone to tax evasion, vulnerable to competition and politically less popular but its success depends on the presence of lesser number of distortions. Even a good GST system may not promise buoyancy in revenue collections if we go by the experience of Ukraine. Although the Ukrainian economy grew by almost 50% between 1998 to 2004 but its GST revenue nosedived by about 32%. Strangely, its GST revenue from import shot up sharply during this period. This meant greater dependence on import for revenue!

With a large swathe of economy going digital and the line between the goods and services getting blurred, there is going to be much more serious challenges for the Governments across the world to ensure rising graph of tax collections. In this backdrop, the larger question is – What are the conditions precedent for success of a new system like GST? As per my research, what may facilitate success are good homework, timely investment in tax administration, sustained education of taxpayers & taxmen, good timing and continued political commitment even in the face of a political disaster. Some of the reasons for failure of the GST system in many countries (at least five countries are known to have introduced and then withdrawn GST) are serious drawbacks in the DESIGN; poor registration process; poor refund mechanism and poor audit. Let’s hope India does not rush into it merely to score a political brownie point and takes cues from the history to make a success out of the historic reform initiative.